Should I Start A Business Or Invest In Property?
The $500,000 question...
Assuming a couple has $500,000 and they are trying to decide whether to buy a house or invest in a business…
WHAT ARE THE BENEFITS OF BUYING A HOUSE OVER INVESTING IN A BUSINESS?
If your focus is on wealth - you are on the right path! All BRW Rich Listers are invested in both property and business.
A rich mindset to adopt is that you want to do both investing in property and a business. So, the question is, what comes first, and how do you decide?
You have many options regarding investing in a business - it could be a micro business based at home, a retail store, a franchise, a partnership or buy in with an existing profitable business or even taking a more passive approach and accumulating blue chip shares.
1) CONSIDER IF YOU'D SUIT ACTIVE BUSINESS MANAGEMENT
Investing in a house can be much more of a passive approach than investing in a business. If time will be scarce, a more passive investment such as a property is better.
Eventually, a business can be highly systematised, and allow you to be more passive, but it will require much more focus, passion and management in the initial years. You may even need to leave a job in order to start the business, whereas with a property investment, you would most likely stay in your job. There are of course paths to building passive income which replaces your job income, via a property portfolio. The property portfolio would be run as a business, with the intent to grow asset value and give you returns.
An alternate passive option is shares. Buying shares is also (in essence) buying businesses. They just happen to be sharemarket listed businesses. This can also be a valid option to allocate your $500,000 capital to a share portfolio.
2) ACCESSING LEVERAGE
Both investing in an investment property and/or in a business employ the concept of leverage. With a house investment the leverage is the loan itself used to buy the property.
Businesses use leverage too. Within a business, leverage can come from using staff time (i.e. have several people working productively for you), using business loans and supplier credit, using a website to sell 24/7 and sell all over the world, using existing intellectual property (i.e. a franchise model) and other forms of leverage.
3) CONSIDER WHAT SORT OF FINANCIAL RETURNS WILL YOU GET FROM YOUR BUSINESS
Essentially, we are talking three growth asset classes here - shares, property, and business. Evaluate each one in turn against each other. Over the last 10-20 years, Australian property and shares have received approximately 7-9% per annum average market returns. Ask yourself, would my business return to me more than 9% gross returns, and compensate me for the extra work, stress and risk I will take on?
On the flipside, a well-run business has the potential to deliver greater dividends than a property investment. If you evaluate that your business could reward you more than 9% per annum, then a business may trump going into property and/or shares.
If you evaluate that your business could reward you more than 9% per annum, then a business may trump going into property and/or shares.
4) The intangible returns of a business:
It's important to realise we also pursue business for creative and personal lifestyle reasons - it's harder to put a price on that, but use Jeff Bezos’ Regret Minimisation Framework (founder of Amazon).
He imagined himself as an 80-year-old man looking back at his life. Jeff's reasoning is that, as an elderly man, he knew that his life’s regrets, more so than anything, would keep him tossing and turning late into the night.
So, when making a tough call on whether to persue a new business venture, Jeff asks himself “Would I regret if I got to my death bed and I hadn't started pursued this idea, investment or business?”
Would your 80-year-old self regret having tried building a startup that had a chance to make real impact — even if it most likely ended in failure? Or would it haunt you that you watched the opportunity pass you by?
ARE THERE ANY DRAWBACKS TO A BUSINESS?
The drawbacks around investing in the business come down to volatility and risk. It's never a sure thing that a business will be a success (even a franchise) and become the smash hit and cash machine that you want it to.
But businesses can be a cornerstone to a couple’s wealth and lifestyle and can be one of the most rewarding assets both financially and personally.
WHAT ARE SOME OF THE FACTORS THAT THE ABOVE COUPLE SHOULD TAKE INTO CONSIDERATION BEFORE DECIDING WHAT TO DO WITH THEIR MONEY?
The key factors in investing in a house over a business really revolve around experience and the planning and due diligence.
You should ask yourself, what are your past experiences in entrepreneurship and business and do these set you up adequately for making a substantial investment of your time and funds in an enterprise?
For due diligence and planning, you should involve at least 1 to 3 months or more of education and then solid planning including a business and marketing plan and financial projections. This is way more important than what the logo looks like!
WHAT ADVICE SHOULD I SEEK?
During the planning, it is also an excellent idea to receive financial planning advice which will help manage your personal and business decisions with regards to finances, returns expected from the business, and business structures. Taxation and accounting advice will also be required and your financial planner can arrange this for you and ensure a joined up ‘core’ of advice.
TRANSITIONING FROM YOUR JOB TO A BUSINESS
If you are currently in a corporate job and have a breadth of corporate experience this will serve you well, especially if you are going into a similar industry.
It is important to have a transition period out of any any job and income so that you can manage your financial commitments and meet the startup costs of the new enterprise.
This is exactly what I did as I transitioned from my corporate finance job to my starting my financial group. I undertook education and relationship building, accumulated savings, and undertook planning and projections to ensure I had a clear path ahead.
INVESTING IN A BUSINESS
Pros of Starting a Business
- Potential for higher returns. Businesses generally offer a greater potential for return on investment than residential property.
- Personal fulfilment. Starting a business may allow you to pursue your goals and creative interests, leading to fulfilment and satisfaction on a personal level.
- Options. “You have many options regarding investing in a business,” Gardiner says. “It could be a micro business based at home, a retail store, a franchise, a partnership or a buy-in with an existing profitable business, or even taking a more passive approach and accumulating blue chip shares.”
Cons of Starting a Business
Can be risky. Many new businesses fail, so make sure you’re aware of all the risks before investing in business. If you have experience in the industry you are going into business in, you have a much higher chance of success (Some studies site a 60% success rate when that is the case).
More expertise is required. Running a business will most likely require more knowledge, expertise and training.
Disruption factor. You may have to leave your current job in order to give your business the attention it deserves.
Lower loan LVRs. Lenders typically offer lower LVRs for business loans compared to residential mortgages.
INVESTING IN PROPERTY
Pros of Investing in Property
- Higher LVRs. Lenders offer higher LVRs on residential loans than commercial loans.
- Much simpler. Investing in property requires less time, effort and stress than investing in business.
- No specialist expertise required. You don’t need specialist knowledge or training to invest in property (although doing plenty of research does help).
- Easier to value. As there are frequent property sales, you should be able to get a property valuation on your asset very easily.
Cons of Investing in Property
- Passive. The passive nature of investing in property can be a drawback for those who prefer hands-on investments.
- Lower returns. Businesses generally offer the chance for higher returns than residential property.
- Liquidity. A house can be hard to sell, and may take a lengthy campaign.
- Tax. You may miss out on tax concessions, such as CGT concessions which apply to businesses.
HOW WE SUPPORT CLIENTS
At Profy Finance and Wealth, we have supported clients who are looking to start a business, or invest in property, through:
- Helping them get clear on their objectives via a Business Planning session
- Recommending and assisting in creating legal structures for the business
- Arrangement and recommendation of commercial lending, investment home loans and business finance
- Having a integrated financial plan, ensuring Finance packages, Superannuation and Insurances match their business situation, family situation and goals
- Helping clients take an active approach to their investments
- Ensuring Debts and Mortgages are well managed and with good providers
- Ensuring wills and estate planning reflect these changes
- Helping them plan for any taxation outcomes
At Profy Finance and Wealth, we cover financial advice and mortgage broking to get more holistic results for our clients. Learn more about how we could help...
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